Now is the time to start your business

Despite the economic turmoil – perhaps even because of it – it’s a great time to start a business. Companies that are formed over the next couple of years or those that are surviving right now through these hard times, will be well-positioned once the financial markets make their turnaround.

By:
Timothy E Taylor
Birmingham Business Journal

The fall of the dot-com era, a confused public market and the anemic initial public offering market all have lined up to create a stagnant early-stage venture economy, but all aspects of the economy evolve around a cycle. So it is only a matter of time until the public equities return, along with the initial public market sector, creating a great opportunity for companies who have survived the lean years.

Venture capital funds and investments in companies have decreased in the last cycle for the following reasons:

# Large funds were raised in the last few years with fewer investment opportunities, which has created an overhang of funds not deployed;

# Distributions to the funds’ limited partner investors are down due to a weak IPO and merger-and-acquisition market;

# Some of the key investors in venture funds are at maximum allocation due to the loss of value in the public markets, and, therefore, the relative percentage of venture investments in their overall portfolio value has increased. Returns have retreated from record levels.

All of these conditions are beginning to settle out and likely will cycle back to a more normal trend in the coming months, making it easier for entrepreneurs to raise money. Entrepreneurs who have survived in this environment probably have learned to be disciplined with their business practices and have had to execute a solid business plan. These businesses likely will be rewarded due to several factors. There are plenty of experienced professionals looking for new opportunities at realistic wages.

Service providers that support early-stage companies are in need of new projects and are happy to accommodate new clients. Venture capitalists and angel investors are starting to make investments and need to deploy investment capital.

These factors, along with inexpensive debt capital, have created a great time for entrepreneurs to start a company.

Finding the funds

"Fine," you say, "but where are the growth capital funds to start my business today?"

While it is true that most venture capitalists and angel investors are busy working with existing companies rather than searching for entirely new concepts during these hard economic times, there is still a sincere interest in companies with excellent near-term revenue prospects. Venture capitalists are not going to ramp product development and teams ahead of customer needs, but they will invest in sound businesses with the anticipation that the broader markets will turn bullish and yield solid future returns. The key difference in venture investing today versus prior to the market correction is the renewed emphasis placed on startups hitting customer milestones, such as landing three beta customers before taking in the second round of financing.

For the entrepreneur trying to start a company using outside investment capital, life has been hard for the last couple of years, but the end of the bear market should create more activity in 2003.

There are several ways startup companies may find funding: boot-strapping (using funds from friends, family, savings and personal credit), angel investors (who are typically high-net-worth individuals who have an interest in investing in young companies), venture capital (which is an outside institutional investor with industry connections), direct investment by a corporation and mezzanine financing (also known as unsecured subordinated debt financing).

Typical exit strategies or liquidation opportunities include mergers and acquisitions, initial public offerings and recapitalizations.

Insider tips

So let’s say you have started your own business and have outgrown all personal and family capital resources.

If you desire to raise your first round of angel or venture financing, consider the following eight insider tips to get the investors to take notice, return your telephone calls, and make the Series A Round Investment in your company:

1.) Develop a strong management team. This is by far the most important aspect of your business as it relates to finding investment capital. People invest in experienced people. If you don’t have excellent experience in the venture, hire a CEO who has a proven track record.

2.) Prepare a business plan that has the following attributes:

# Has a strong, succinct and convincing executive summary. http://matr.net/stepstosuccess.phtml

# Answers a fundamental market need, not just solving a problem.

# Has a product with at least a billion-dollar market potential.

# Demonstrates a strong competitive advantage.

# Is protected by intellectual property such as patents and trademarks.

# Is in a market that is growing and perceived by Wall Street as being the "next big thing."

# Has realistic financial projections that suggest more than $50 million in sales by year five. If your business does not support this level of income, you likely are not going to be able to attract venture capital.

# Is well-written with no grammatical or technical errors. (Most VCs think if you cannot write, you are likely to be a poor businessperson.)

3.) Develop an "A list" of board advisers with strong academic backgrounds and relevant business experience.

4.) Be willing to give up 25 percent ownership or more in your company to raise the first institutional round of financing.

5.) Hire "name brand" attorneys and accountants and listen to their advice.

6.) Grow your business one customer at a time and work a plan that will show real revenue.

7.) Be realistic about the valuation of your company.

8.) Keep your monthly burn rate as low as possible and spend money only on efforts that will boost sales.

Continued return on investment

The venture capital business has grown dramatically over the years and will continue to provide solid double-digit earnings for its investors. Historically, venture capital has out-performed the S&P index, private equity and mezzanine investments.

Because venture investments have generated an annual lifetime return in excess of 30 percent IRR (internal rate of return), continued interest in venture funding, especially early-stage opportunities, will remain.

The primary change in recent venture investments has been a shift away from ".com" seed-stage deals and toward more mature companies with solid revenue growth in industries such as life sciences, software, network equipment, medical devices and wireless technologies. If you’ve got the right stuff in these markets, now is the time to launch your new business.

Timothy E. Taylor is director of investments for Harbert Management Corp. in Birmingham. He can be reached at [email protected].